Sunday, April 02, 2006

Weekend Reading for the SEC

Now that the SEC has declared open season on journalists and research analysts at the apparent behest of an insecure CEO cleverly shifting the spotlight away from his own money-losing public company track record, it is worth looking back to a time when such brittle, blowhard CEOs were the norm, not the exception, to glean what lessons such eras might teach to investors and regulators alike.

The era of which I’m speaking is the roaring 1990’s—the last bubble period, when companies came public on not much more than a Cool Idea and a slick road show.

And anybody who wants to look back and see what happens when the SEC fails to rein in banking-happy analysts and rule-flaunting CEOs need look no further than “Confessions of a Wall Street Analyst,” a new book by former telecom analyst Dan Reingold.

Reingold’s book describes the arc of his career from MCI number-cruncher to Wall Street star to depressed and disillusioned retiree, and it is not a bad read.

I didn’t know Reingold when he was an Institutional Investor-rated analyst famous for his upgrade of the Baby Bell stocks just prior to their Clinton-era deregulation, but he comes across as earnest and well-meaning, if a little too dependant on “models” and “spreadsheets” for my taste: garbage in, garbage out, as they say.

And man did he hate Jack Grubman.

Although some book reviewers of “Confessions…” disliked the anti-Grubman theme, I think that angle actually gives the book depth and heft, and makes it far more readable than just your average sell-side story. After all, how many times can you read about secret negotiations in a plush Manhattan hotel room with a Wall Street firm trying to hire an analyst away from whatever firm he’d just joined?

Furthermore, it is the Grubman angle that brings back all the excesses of the 1990’s, and provides the lessons that I mistakenly thought we had all learned about how Wall Street analysts and public companies ought not to conduct themselves.

Aside from Grubman’s famous upgrade of AT&T just prior to the AT&T Wireless spin-off, Reingold gives chapter and verse on Grubman’s incestuous Worldcom relationship, especially instances when clients apparently heard takeover stories—and exact prices—from Grubman well before the public announcements.

But the chapter most relevant to today’s climate of fear and loathing in the press and among those who would speak skeptically of a public company is called “Crash and Burn,” in which Reingold describes how the whole house of telecom cards begins to crumble—kicked off in part by terrific research from a Reingold competitor, who knew to look not just at the numbers, but behind them.

Simon Flannery was Morgan Stanley’s telecom analyst, and he downgraded Qwest—once the hottest of the telecom hotties—in mid-2001 “on a bunch of arcane accounting concerns,” as Reingold puts it.

Reingold himself “studied the [Flannery] report carefully” but for whatever bizarre reason did nothing else about it. He didn’t pick up the phone and talk to accountants or industry people, didn’t get on a plane and sit down with the Qwest auditors—nothing but reiterate his “Strong Buy” on the stock and listen to a Qwest conference call in which Qwest CEO Joe Nacchio denounced the report.

On that call, Nacchio 1) claimed there were no accounting problems at Qwest, 2) attacked Flannery, 3) attacked Morgan Stanley, 4) attacked Morgan Stanley’s CEO, and 5) banned the analyst from visiting the company or asking questions on the call.

Now, we all know that Flannery was right, and Nacchio was wrong; that Qwest ended badly, and Joe Nacchio’s career at Qwest ended badly.

(The SEC eventually charged Nacchio and others with “massive financial disclosure fraud”—three years after Nacchio resigned.)

But, at the time, Flannery was successfully made out to be the bad guy by a CEO eager to shift the spotlight away from the analysis itself.

It’s a story worth re-reading, to remind ourselves of what happens when CEOs attack the person asking the questions, instead of answering the questions and letting the business prove the skeptics wrong.

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

8 comments:

Why should companies answer questions from bashers who will just use the answers against them? Conference calls should be for the good people to talk to the company. At least that's what the good people who promote perpetual motion machine schemes tell me.

I am constantly amazed at many people in the investment world who disparage the OSTK issue.

Even you should agree that naked shorting (other than some very narrow conditions performed by the market makers) is illegal. The on going saga of the OSTK and the naked shorts should be ended. The SEC should enforce the rules and force all those shares to be covered.

The SEC should also force all the naked shorts grandfathered in to be covered. Again these are an illegal act which dilutes shareholders.

But many of you in the media choose to support the big hedge funds and sweep this issue under the rug by talking down the targeted company.

This naked shorting scheme has put many small companies either out of business by choking off their access to wall street funding or hampered their growth.

MAG: Maybe the SEC should start enforcing all the promoting by the people who run companies. Naked shorting, though illegal and definitely something that should be stopped, is a minor practice compared to promotion and dumping by company managements. The media, analysts, etc. are 99% on that side of the business. The conspiracy, if one actually existed, would be on that side, not on the short side. Maybe someday OSTK will actually turn a profit.

I had a meeting with Flannery shortly after the downgrade, and let me tell you, that guy was getting a tremendous amount of static from inside and outside MSDW. It was a truly great call, and one that was based on a lot of hard work and courage. I met Nacchio (both before and after the Flannery call)and he was, even by CEO standards, a sleaze. He got a lot of latitude from the street, though, because he was a sleaze with gravitas.

FWIW, I've never met Byrne but have talked to some who have. My impression is that he's not a sleaze; he's just spacey and misguided. Nacchio would never have said "my bad" in a press release; he would've just blamed somebody else.

Jeff, you may choose to delete this because it isn't really a response to your excellent piece; it's a response to one of the comments. Also, it's on the issue of naked shorting, which is divisive and has the potential for cluttering your website.

In any event, Mag has entered a comment with a number of inaccuracies.

First, Mag said that the "SEC should...force all the naked shorts to be grandfathered in to be covered." The only grandfathering was for Reg SHO buy-ins; they weren't for CNS buy-ins. There are no fails from that period which still exist; they have all long since been bought in, following CNS rules.

Second, Mag said that "many of you in the media choose to support the big hedge funds and sweep this issue under the rug by talking down the targeted company". Huh? I don't know how Mag could have missed the recent 13G from a BIG hedge fund. They're long. Very. It's a few small hedge funds who are short.

Third, Mag said, "This naked shorting scheme has put many small companies...out of business." This is an oft-repeated claim, yet I periodically ask for just ONE example--a company with a real product, without a toxic convert, and without massive dilution from the insiders. I'm still waiting.

"mark leh": Far from not posting this response to a previous comment because it touches a "controversy," I welcome such a reasonable, informed, straightforward post.

The naked shorting "controversy" is controversial mainly because a certain CEO has effectively turned it into a smokescreen for his own problems, and countless uninformed message board fanatics have grasped it as tangible evidence that their own poor investment decisions were not due to their being stupid, but being pawns in a vast conspiracy against them.

Ignoring the naked short bs -- how come no one ever rationally discusses Overstock's business prospects or valuation in public? The Yahoo message boards are filled with zany characters who know nothing. But in reality, Overstock is incredibly cheap if it survives, and it seems the only reason to short it is a bet that it's going bankrupt. In today's loose capital markets with very low risk premiums, why would you short a stock that will fly upward on any hint of positive news? And can raise new capital if need be from yield-seeking idiots?